Reputation Risk

Updated on May 29, 2024
Article byWallstreetmojo Team
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

What is Reputation Risk?

Reputation risk is a term used to describe the potential of an organization losing its status as a respected entity and then being treated as dishonorable. Effective reputation management benefits an organization in various ways, including building trust with stakeholders and motivating management to perform with social responsibility.

The risks that might damage an organization’s prestige are numerous and diverse. For example, it might result from a security breach, unfair labor practices, the possibility of lawsuits, product shortages, or environmental damages. In certain firms, a whole department is dedicated to maintaining the organization’s social status by predicting and understanding the unique hazards that may harm them.

Key Takeaways

  • Reputation risk definition portrays it as a hazard that is dangerous to a good name built on trust and belief. Once it happens, it may take a lot of effort to reverse the effect and maintain it.
  • Many factors can trigger damage to reputation. Major ones include morally wrong management acts, security breaches, and lack of environmental concern.
  • It is vital to ensure the performance falls in line with the expectations to maintain a reputation. For this, management should identify and understand risk elements and develop strategies to maintain reputation.

Causes of Reputation Risk

The emergence of reputation risk can be linked to the repercussions of other business risks. Therefore, examining the potential elements impacting reputation might reveal many other business threats.

Reputation Risk

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  • Morally wrong management acts: A company can directly damage its reputation by adopting worse business practices and, for instance, holding on to a poor corporate governance practice, noncompliance with applicable laws and regulations, misconduct of senior management- fraud and corruption, failure to meet customer’s expectations adequately, and compromising on quality. Exposing these practices to the public can result in customer loss and damage to the company’s reputation, brand value, and questioning ethics and integrity.
  • Security breaches: An organization will lose reputation if it can’t successfully block or confront security breaches, cyber-attacks, cyber threats, and data breaches.
  • Lack of environmental concern: Going green initiatives and acting towards environmental protection is increasing. Businesses who ignore the environment in the drive for profits may discover that it backfires them.
  • Third-party activities: There are scenarios where an organization has to answer for the negative behaviour of third parties like their suppliers, vendors, and other affiliated parties. When a third party that the company works with becomes embroiled in a matter that is embarrassing or otherwise damages their reputation, and by extension, the reputation of all parties affiliated with it. 
  • Decreasing financial performance: When a company cannot make a profit, or the revenue is falling incessantly. It will lead to a negative perception of stakeholders.

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Reputation Risk Example

Let’s look into an example explaining a scenario and its potential in tarnishing a company’s reputation due to a third party’s unethical or incompetent practice.

Imagine a scenario in which a company uses the service of a third-party shipping company. In these cases, problems with shipping such as late delivery and delivery to the wrong address can cause blame on the producer, not the third-party service provider. Since the shipping company is only involved in shipping, clients may not know the third party involved. It slowly erodes the company’s reputation, to the point where it has mostly negative reviews, especially when it comes to shipping. It leads to the loss of many potential and existing customers.

How to Manage Reputation Risk?

Reputation is a commercial asset, and damage can be very costly affecting corporate value and public trust. For instance, organizations may have difficulty generating new business because of damage to their reputation from various scandals. Hence protecting reputation from damage is all-important.

The key to effective reputation risk management is to perform above the stakeholders’ expectations. Therefore, management should define a bad reputation within the corresponding market and local environment, develop robust strategies, and have efficient customer relationship management. Moreover, entities can also focus on having reputation risk insurance.

Some of the strategies include integrating risk identification procedures in business planning. For example, the individuals steering the company (the board and executives) should identify risks that are most likely to affect its reputation and mitigate them before it’s too late. A preventative measure is through practical training, letting the staff members know that whatever they do will reflect the business.

A review of the workplace culture may also be necessary, especially when planning to expand the company’s operations to other countries or regions. One may find that the behavior in these new places is not similar to what the employees are used in their previous site. Therefore, they may do or say perfectly fine things in their native culture, but which is a faux pas in the new region. Therefore, before setting up business in another part of the world, it would be wise to research the standard etiquette in the area.

These are just a handful of the many ways of managing or preventing. Nowadays, the advent of the internet has broadened the scope of reputation risk. As a result, it is not uncommon that social media may significantly influence corporate-level strategic initiatives. Its acknowledgment is essential to succeed in today’s competitive environment.

Frequently Asked Questions (FAQs)

What are examples of reputation risk?

A company that produces industrial waste could outsource the destruction of such harmful waste to another company that engaged in doing so. However, suppose it turns out that the method they use to get rid of the waste is detrimental to the environment. In that case, the public will blame the firm responsible for waste destruction and the company producing the waste. It could lead to a boycott of the company producing harmful wastes as by-products.

What causes reputation risk?

Threats to the reputation of an organization can emerge from diverse sources—for instance, poor industrial relations, anti-environment practices, delivering defective products, and security failure.

Why managing reputation risk in banking is essential?

When a bank engages in high-risk activities in the absence of risk management practices, it can cause an increase in the events that pose a threat to their reputation, which in turn affect the bank’s power to attract deposits, investments, and mandates. As a result, it has resulted in a renewed emphasis on reputation management and the necessity to revive a bank’s reputation.

This article has been a guide to Reputation Risk and its Definition. Here we discuss the causes of reputation risk and how to manage it, along with examples. You may learn more about financing from the following articles –